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A Nice Simple Tax – The “Reform” of Capital Gains Tax

A Nice Simple Tax – The “Reform” of Capital Gains Tax
Of all the changes announced in the Pre-Budget Report, probably the most far reaching, illogical, and unfair are the changes to Capital Gains Tax (CGT).

 

CGT was described to me years ago when I was a trainee inspector as a “simple” tax. At that time, I suppose it was. You could work out the CGT on a transaction in your head, whereas for income tax or inheritance tax, or any of the other Treasury fundraisers, you needed a pen and paper, a calculator, and some reference books.

 

Of course, like all simple taxes, CGT was unfair – think of the Poll Tax which could not have been simpler!

 

One of the main objections was that it was effectively a tax on inflation. In cash terms, during the 1970s assets were increasing in value at a huge rate, but still you paid 30% of the difference between their cost and the sale proceeds you received.

 

The indexation allowance was introduced to deal with this, allowing you to increase the cost of the asset in line with inflation, so you only paid CGT on the real increase in value.

 

In 1998, indexation was “frozen” for individuals and trusts (it still applies to companies). In its place was put Taper Relief. Given that the Chancellor at the time was Gordon Brown, this was amended and amended and reformed and revised until it became extremely complicated, but the basic proposition remained simple – taper relief rewarded those who invested for the long term and it rewarded traders more than investors.

 

Any investor could look forward to a reduction of up to 40% in the gain that was chargeable to CGT after he had owned the asset for ten years, and the owner of a trading company (or a partner or sole trader) could have 75% of his capital gains exempted from tax if he had owned the business for two years or more.

 

The rate of CGT charged depended on your other income and gains for the year – 20% if you were a basic rate taxpayer and 40% if you paid higher rate income tax.

 

All that is being swept away for individuals and trustees, because the old indexation rules will still apply to gains made by companies. From 6 April 2008, all gains will be taxed at 18% no matter what the asset, how long you have owned it, and what other income you have.

 

There will be some winners. In particular, this is good news for buy to let residential landlords as currently the lowest rate of CGT they can ever hope for (as a higher rate taxpayer) is 24%. It is also good news for people who play the stock market, who will pay 18% on their gains instead of (typically) 40%.

 

It is bad news for family trading businesses, entrepreneurs, and (ironically, given the chancellor’s stated purposes) people on low incomes making gains just over the annual exempt amount (currently £9,200). For example:

 

Mr Jones owns a few shares his father left him 10 years ago. He is short of cash and has little income so he sells the shares and makes a gain of £20,000. Taper relief reduces this gain to £12,000, and after his annual exempt amount he pays CGT on £2,800. As he has little other income his CGT is charged at 20%, so he pays £560 in tax.

 

If Mr Jones waits until 6 April 2008 to sell his shares, he will be taxed at 18% on the gain above the annual exempt amount. £20,000 less £9,200 is £10,800, so his tax bill will be £1,944.

 

You will have noticed that the second sum is much simpler to do, but I suspect Mr Jones would rather have had a slightly more complicated system that took account of how long he had owned the shares, and the fact that he has a low income.

 

If you have assets you may want to sell in the next year or so, you need to work out if you are going to be a winner or a loser as a result of the changes.

 

If you will be worse off on a disposal after 5th April 2008, you should consider taking steps to “crystalise” the gain before 5th April so that you pay less tax. CGT on a gain “crystallised” before 5th April 2008 is payable on 31 January 2009, so as long as you actually sell the asset before then, you will have the cash to pay the tax.

 

Gains can be “crystallised” by several different methods (such as transferring the asset to a “settlor interested trust”), but this is a job for a tax specialist.

 

If you will be better off selling after 5th April 2008, it is tempting to hang on until then, but if you already have an eager buyer who has made you a good offer, this may be commercially unwise. Once again, a good tax consultant can come to the rescue and arrange to defer the point at which the capital gain “crystallises” until after 5th April, even though for practical purposes the sale takes place before then.

 

There is only one way to be sure whether you will be smiling or frowning after 5th April – and whether you therefore need to indulge in a little time travel for tax purposes - get out the calculator and do the sums!